| Business Encyclopedia: Global Economy |
The global economy refers to the increasing integration of fragmented national markets for goods and services into a single global market. In such a market, companies may source from one country, conduct research and development (R&D) in another country, take orders in a third country, and sell wherever there exists demand regardless of the customer's nationality. Kenichi Ohmae (1989), a Japanese consultant, calls this the borderless world. While nobody would argue that national borders are completely irrelevant, certain influences have caused the globe to become smaller and smaller. These include technological advances in global communication and transportation, the dilution of culture, a decrease in tariff and nontariff barriers, and a self-feeding change in the degree of global competition.
International Trade
To comprehend the recent increase in global markets, it is important to have some under-standing of the historical development of international trade. While some form of international trade existed prior to the colonial expansion of Europe in the fifteenth and sixteenth centuries, mercantilism, or the trading of gold and silver for goods, served as the precursor for the large flows of goods, services, and information that currently exists. This philosophy of national power postulated that those countries with large amounts of specie could maintain the types of armies necessary to conquer other nations. The conquered nations then provided additional sources of revenues either through goods, slave labor, or gold and silver that could be used to support additional armies, thereby creating a "virtuous" cycle.
From the demands of war, trade theory has moved through a number of stages. Adam Smith, the Scottish economist and philosopher, stated that countries traded because they had an absolute advantage. One nation's workers could produce a given product more efficiently than workers in other countries. Rather than produce those products that it could produce but poorly, a country could specialize and exchange those products it produced efficiently for those produced efficiently by another country and, therefore, increase its overall wealth.
David Ricardo altered this theory to suggest that a country need only have a comparative advantage in order to specialize and trade to increase wealth. A country having an absolute advantage in two goods might find that it would still rather specialize in that good for which it had relatively greater production expertise. It could then trade its excess for a greater quantity of the second good than it could have obtained had it split its production between the two goods.
These theories of trade were followed by Hecksher and Ohlin's theory of factor proportions (1933), which suggested that countries will specialize in the production and trade of either capital-intensive products or labor-intensive products, depending on whether their comparative advantage lies in capital or labor. Other theories of trade include Vernon's product cycle theory, which suggests that a country's comparative advantage in products changes over time as the technology to produce that product changes, and Porter's writings on the competitive advantage of nations, according to which a nation's competitive industries depend on domestic rivalry, demand conditions, factor conditions, and the strength of related and supporting industries.
Causes of Increasing Globalization
During the time that different trade theories have risen and fallen, the world has become a smaller place. One of the primary facilitators of the global marketplace is the technological advance of the telecommunications industry.
In the days of Adam Smith, if a merchant wanted to trade a lot of wool for a case of port wine, the communication of that intent would require weeks. Sending a message to a subordinate in India took months. Such circumstances lent themselves to fragmented individualized markets with subsidiaries run by family members or close friends. These in-country managers were trusted to make decisions in the best interest of the company because no rapid means of communicating new opportunities and information existed. The opportunity to closely coordinate the activities of several foreign operations simply did not exist.
Today, communication between most parts of the world is instantaneous. A manager in Bonn can telephone a manager in Rio de Janeiro to discuss the latest news regarding the orange crop. If the Brazilian manager wants to send some contracts to the German manager, it can be done by fax; if the data demands are larger, the information can be transferred via the Internet. Should the Brazilian manager then need to travel to the middle of the Amazon rainforest to check up on the supply of a certain healing plant, that information can also be passed on to Germany through a sophisticated cellular phone.
These new capabilities allow vast amounts of business data to be transferred almost instantaneously all over the world and at ever-decreasing costs. The cost of a three-minute phone call between London and New York fell from $13.73 in 1973 to $1.78 in 1993.
These gains in communication technology closely parallel those in the transportation industry. P. Dicken (1992) indicates that between 1500 and 1840 the best average speed of horse-drawn coaches and sailing ships was about ten miles per hour. Between 1850 and 1930, steam became a dominant technology, with trains averaging sixty-five miles per hour and ships increasing their speed to thirty-six miles per hour. In the 1950s, propeller aircraft achieved speeds of three hundred to four hundred miles per hour. These speeds later increased to over six hundred miles per hour with the advent of the jet-engine technology. Again, what this means is that an executive who used to spend several weeks traveling from Lisbon to Rio de Janeiro to visit a factory could visit factories all over the world in that same amount of time.
These advances have greatly increased the potential for flows of goods and individuals across national borders. Further advances include such things as standardized shipping containers, which can be easily transferred from sea carriers to land carriers and can be packed with greater efficiency. In addition, the vast size of modern supertankers has greatly increased the amount of goods that can be shipped at one time.
In addition to advances in transportation and communication, some scholars, such as Theodore Levitt (1983), have argued that the world has become a smaller place in terms of tastes and preferences. The tastes of teenagers around the world may be as much informed by Hollywood movies and MTV as they are by cultural heritage. Levitt argues that such convergence of preferences is not limited to any one age group, since adults worldwide enjoy Chinese food, country music, pizza, and pita bread. While some convergence has certainly taken place, scholars such as Susan P. Douglas and Yoram Wind (1987) argue that this cross-border similarity of tastes and preferences is limited to certain countries and product lines.
While the extent of convergence is certainly arguable, it is clear that at least in some countries and with some product lines, the tastes and preferences of consumers seem quite similar. This reality encourages a global-market approach to business as companies attempt to reach the largest number of consumers at the lowest price possible.
Another factor leading to a more globalized marketplace is the historical decrease in tariff and nontariff barriers. In 1930 the United States raised tariffs under the Smoot-Hawley Tariff Act to an average of 53 percent. Other countries followed suit, and international trade slowed significantly. In 1947 several leading trading nations created the General Agreement on Tariffs and Trade (GATT) to serve as a forum for bringing down trade barriers. Between 1947 and 1994, trading countries around the world have participated in eight rounds of negotiating in an effort to reduce tariffs. The latest round, entitled the Uruguay round, boasted 117 participants and resulted in an average tariff reduction of 35 percent. As tariff barriers fell, the inducement to trade was increased as foreign-produced goods became more and more competitive with domestic goods.
In addition to the GATT agreements, several countries have participated in regional agreements encouraging even lower tariff rates among participants. An example of such an agreement is the North American Free Trade Agreement (NAFTA) implemented by Canada, Mexico, and the United States in 1994. This agreement reduced tariffs over a fifteen-year period, lifted many investment restrictions, allowed for easier movement of white-collar workers, opened up government procurement over a ten-year period, and created a mechanism for dispute resolution. As a result, retailers such as Wal-Mart and 7-Eleven have expanded operations into Mexico, and many Mexican and Canadian firms have been enjoying the benefits of participating in the world's largest consumer market, the United States. In the first two years of NAFTA's implementation, trade among Canada, the United States, and Mexico increased by 43 percent.
In addition to NAFTA, numerous other such agreements exist, including the European Union, the Carribean Community and Common Market (CARICOM), the Economic Community of West African States (ECOWAS), the Association of Southeast Asian Nations (ASEAN), and the Andean Common Market (ANCOM). Each of these agreements seeks to promote trade through minimizing the barriers to trade that exist in the region.
Closely related to the liberalization of trade, technological advantages, and the convergence of consumer preferences are a set of competitive factors centered around the ideas of economies of scale (larger production volumes generating lower per-unit production costs) and locational advantages. Marquise R. Cvar (1986) cites the example of Becton Dickinson, which in the 1980s was faced with new technologies in disposable syringe production that could dramatically decrease the cost of these medical devices. Unfortunately, the investment needed in technology was so high that, to be efficient, the company would have to capture 60 percent of the U.S. and Japanese markets. Further, it was believed that by doubling volume, cost would decrease by 20 percent. Becton Dickinson responded by creating standardized syringes for markets in the United States, Europe, Mexico, Brazil, Australia, the Philippines, Singapore, and Hong Kong. In so doing, they were able to reduce the cost of their product to 5 to 10 percent below those of local competitors while simultaneously providing generally higher quality. These savings led to an average market share of 45 percent in those countries.
Further, this standardization approach also allowed Becton Dickinson to shift production among various plants located in the United States, Ireland, Spain, Mexico, and Brazil. As exchanges rates fluctuated, the company was able to increase production at more cost-effective plants while decreasing it elsewhere, resulting in even greater savings. Further, companies in such situations may use profits in one country to subsidize their competitive activities in another. While anti-dumping laws prohibit selling exported goods at a price below their cost of production or at a price lower than the price in the home market, companies will sometimes seek to attack a competitor in a foreign market by engaging in dumping-like pricing in an attempt to wrest market share. If the firm under attack has operations in the foreign firm's home market, it can respond in kind. A purely domestic firm does not have such options.
In response to the competitive advantage enjoyed by global companies such as Becton Dickinson, local firms often respond by becoming more global themselves. This cycle has created a more worldwide competitive market for a large number of products and services.
Conclusion
Changes in communications and transportation technology, convergence of consumer tastes and preferences, trade liberalization, and the emergence of global competitors have all combined to create a much more integrated world economy. Companies like Becton Dickinson, Unilever, and Samsung profit from larger numbers of consumers and cheaper factors of production, while consumers may experience lower prices and higher quality. Of course, some might argue that the benefits of the global marketplace come at a price. Membership in trade organizations such as the World Trade Organization (WTO) may limit a country's ability to create laws regarding the conduct of business within its borders since each law must pass the scrutiny of the WTO. In addition, the interrelatedness of markets may cause a negative domino effect within a region, as happened with the Asian crisis of the 1990s. Despite these and other concerns, however, the global marketplace seems likely to continue its expansion as new technological advances continue to shrink the importance of geographic distance.
Bibliography
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Daniels, John D., and Radebaugh, Lee H. (1998). International Business: Environments and Operations, 8th ed. Reading, MA: Addison Wesley.
Dicken, P. (1992). Global Shift. New York: Guilford.
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[Article by: NORMAN S. WRIGHT]
